Fat tails. These skewed beasts can bulge out from nowhere and push investment returns far into positive territory or claw portfolios into the red. While investors can never know when the next financial calamity will strike, or what form it will take, they can maintain strong defensive exposures. But which assets will truly keep capital safe, and how much should superannuation funds allocate to them? SIMON MUMME reports. Super funds are invariably overweight riskier, returnseeking assets. They need to be, if they are going to generate returns above inflation and keep up with the performance of their peers. This leaves less room for defensive exposures – investmentgrade debt, cash and, more recently, hedge funds – to insulate them from fat-tail whippings.

And with no indication that traditional strategic asset allocations are going to significantly change any time soon, funds must ensure that what they have in their defensive strongholds will preserve capital. They have a range of choices. Some managers, such as bonds’ heavyweight PIMCO, say that continuous, options-based hedging strategies can make portfolios more resilient to large shocks. But this protection comes at a hefty price. Some investors, such as Sean Henaghan, investment director of AMP Capital Investors’ $96.9 billion Future Directions Funds, believe that smart diversification can suffice. “Good diversification can provide fat-tail protection – you don’t have to buy a product that’s going to give it to you,” Henaghan says. Investors burned by the credit crunch should not be scared into building portfolios that will perform well if, say, a subsequent recession were to hit. If they do so, they will not be prepared for the future, Henaghan says.

The answer is to maintain exposures to truly defensive assets, which, by their nature, provide steady return streams independently of growth assets. In long-term asset allocations, defence should not be prioritised above growth. This would be unproductive, says Jim Christensen, chief investment officer of the $10 billion Telstra Super. If an investor is too cautious, they “leave a lot of opportunity on the table” and run the risk of underperforming. Because small defensive tilts “doesn’t help” returns in a crisis, funds would need to make large, structural asset allocation changes if they were going to go defensive in a big way. But large defensive exposures are an imposition on higher return-seeking portfolios. “Portfolios that have too much cash are very hard to turn around quickly,” he says.

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